Improving overall climate key to FDI flows: IMF

ALTHOUGH India is on foreign investors' radar screens as the most attractive destination for quite some time, the interest has not yet translated into actual FDI (foreign direct investment) flows. The reason why this conundrum remains is to be found in the latest study of the International Monetary Fund (IMF).

"India: Selected Issues" prepared by a staff team of the Fund as background document for periodic consultation with the member country and just released in Washington contends that FDI flows into India have risen since the 1990s but remains low compared with other emerging markets. In 2002, India received FDI inflows of less than 1 per cent of GDP, whereas China received FDI worth 3.7 per cent of GDP. In dollar terms, China received 15 times the FDI India did.

The Fund economists note that standard determinants of FDI include labour market conditions, the quality of infrastructure, corporate taxation, inflation, trade openness, market size, corruption and administrative procedures and bottlenecks. They said existing qualitative work on India enumerates factors limiting FDI such as, relatively high tariffs and limited scale of export processing zones, stringent labour laws, high corporate tax rates, exit barriers, a restrictive FDI regime. Stating that the investment climate in other emerging markets in Asia appears to be more conducive to attracting FDI inflows, the Fund said that compared with selected Asian countries, India's overall infrastructure quality ranks low. This is aggravated by the significant burden of bureaucratic red tape and regulation in India. Whereas, for the same average in countries to begin a business is 43 days, it takes 89 days in India. The enforcement of contracts takes longer in India (425 days) than the average 266 days.

Citing some independent study using a model, the IMF economists said if India halves the number of days needed to start a business or halves the years to resolve insolvency, FDI could rise by 0.7 percentage points and 1.4 percentage points of GDP respectively.

Other conclusions of the study, point out a decrease in India's marginal corporate tax rate to that of China would increase FDI by one percentage point of GDP; an increase in trade openness in India to China's level would garner another 0.6 percentage points; Improving regulatory quality in India to the level of Thailand would add another percentage point.

The IMF study found that FDI has been concentrated in a few Indian States. During 2000-03, five out of 29 rapidly growing States received 60-70 per cent of FDI inflows into India: Andhra Pradesh, Delhi, Karnataka, Maharashtra and Tamil Nadu. Even among these States, there is considerable heterogeneity. Maharasthra received more than 10 times the amount of FDI per capita than Andhra Pradesh in 2000. It is also these very States that are most successful in converting FDI approvals into actual inflows.

They say labour market flexibility appears to be crucial in determining FDI as States with most mandays lost due to strikes fare worse in terms of FDI inflow. There is some evidence that infrastructure is also a determinant of FDI location and States with higher teledensity attract more FDI.

Pointing out that State-specific policies and incentives to attract FDI are not a substitute for improving the overall business climate, the IMF study said this is borne out by the experience of States such as Haryana, Himachal Pradesh and West Bengal, which offer incentives but attract little FDI.

Since the most important factors swaying FDI into India are not FDI-specific policies but rather broader economic policies including corporate taxes, trade openness and other business climate issues such as regulatory quality and burden, the extant global attention on India's tremendous potential for FDI is an "opportune time for rapid progress on structural reform to drastically increase FDI flows", says the Fund study.

(This article was published in the Business Line print edition dated March 13, 2005)

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